China’s risky new money supply

Commentary: New tool-kit needed for China’s funding surge

HONG KONG (MarketWatch) — Investors have always needed a different tool-kit when it comes to deciphering China’s monetary policy. Now it needs another update as new funding sources explode.

Traditionally in China’s state-driven economy, monetary policy has been about the quantity of money rather than interest rates. Whereas in the U.S. all eyes are on the Fed’s rate policy, in China, it’s typically loan quotas that make the headlines.

Investors have also grown used to bank lending as a proxy for economic growth, given so many loans go to fixed asset investment by state-owned enterprises (SOEs). If you want faster growth, simply look at the pace of lending, particularly by the “Big Four” state banks that can supply up to half of all domestic lending.

Using the old tool-kit would suggest authorities see slower growth in the year ahead. Reports suggests China’s “Big Four” banks have nearly 3 trillion yuan ($482.63 billion)
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in new lending quotas for 2013, up only slightly from 2012.

China’s banks are believed to have extended 8.3 trillion yuan in local currency loans last year and its central bank has a target of 8.5 trillion yuan this year, according to reports.

But this misses the real funding picture. Bank lending is becoming much less important after an explosion in trust loans and corporate bond issuance in the past year.

New figures reveal bank loans now accounts for just 52% of the economy’s total fund raising — a record low. In fact, trust loans surged 679% in December alone to 264 billion yuan from a year earlier, according to new bank data last week.

China’s banks are believed to have extended 8.3 trillion yuan in local currency loans last year and its central bank has a target of 8.5 trillion yuan this year, according to reports. But this misses the real funding picture. Bank lending is becoming much less important after an explosion in trust loans and corporate bond issuance in the past year.

Helpfully, China has now coined a new term to measure these emerging funding channels “Total Social Financing” (TSF). This measures total fund raising in the economy, including not just bank lending, but trust loans and bonds, which were up 23% last year.

This means in retrospect, for much of last year, the market was tracking the wrong indicators.

If we rewind to early in 2012, mainland authorities were criticized for not more aggressively loosening policy, despite signs the economy was lumbering further into a slowdown.

One theory was China’s banks were facing supply constraints as deposit growth slowed and bank loans to provincial governments were rolled over, rather than repaid.

Many analysts argued a slowdown in bank lending was unavoidable after earlier lending sprees.

And while bank lending started strong in 2012, it continued to decline.

After April saw bank lending peak at 1 trillion yuan, monthly lending continued to fall, ending the year at roughly half that in November and December.

If you look simply at these lending figures, they are hard to square away with the recovery in China’s economy since the last quarter of 2012. Property prices have begun to rise, and fourth-quarter GDP growth was stronger than expected at 7.9%. This also helped full year growth come in at 7.8%, again ahead of expectations.

This is all timed very handily for Xi Jinping’s new government, who can also point to a rebound in markets since he took office. The Shanghai Composite Index
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is up 18% since December lows.

The lesson here is if investors were still watching bank lending figures, they would have missed the upturn. In fact, that is the way weaker lending numbers were typically reported at the end of last year.

Still, the growth spurt in these new lending channels raises various questions.

First, is the sustainability of this growth. Trust lending, which sees non-financial institutions get involved in lending at typically higher rates than banks, looks to be continuing apace.

By November last year,145 institutions controlled capital assets worth 3.44 trillion yuan ($553 billion), and managed funds worth more than 30 trillion yuan for their parent companies, according to data released by China Securities Journal. Likely, the appetite for bond issuance will remain robust, at least until there is any default.

Clearly, China’s government, through its network of SOEs, retains an impressive ability to turn on the liquidity stimulus when it wants to.

The other question troubling investors, however, is whether these new funding sources are adding to systematic risk in the financial system?

Much of so-called ‘trust lending’ isn’t just higher interest rates, but also shorter duration. Some of the funding is also tied into the growth in new wealth management products that have been subject to recent default scares.

Some analysts are already questioning whether China’s illiquid bond market is really just more than new loans in disguise. The vast majority of issuers are SOEs, while state banks are the main buyers.

It seems a new tool-kit is needed to understand how China finances its growth. No doubt investors will be looking more closely at the funding costs behind China’s recent growth spurt, particularly as earning season approaches. But for now at least, that reckoning is postponed.

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